What is interest and why do banks pay it?

Interest explained

Interest is what someone pays someone else for temporary use of their money – banks pay consumers for temporary use of their money, and consumers pay banks and credit card companies for various types loans, which is a temporary use of that bank’s money.

Banks offer consumers interest on savings accounts, and sometimes checking accounts, as incentives for consumers to put their money in that bank. When the consumer is not using the money, although it always remains in the account of the consumer, it is not sitting idle somewhere, as if it were under a mattress.

The bank is using the money – to make loans to other consumers, companies, and banks, and to make investments. Interest is the bonus banks pay consumers for allowing the use of their money, for effectively lending the bank that money.

Annual Percentage Yield (APY) is the amount of money an account earns over the course of one year, and includes compound interest earned. Compound interest means that once an amount of interest is added to the account, it will also earn interest – so it’s interest earnings for previous interest earnings.

A higher APY means that the account earns more money. Annual Percentage Rate (APR) typically refers to loans, and is the amount of money a bank earns, and consumer pays, over the course of a year, expressed in a percentage. These are standardized numbers that makes is easy for consumers to compare interest rates offered by different accounts and different loan offerings.